The work of preparing financial statements — called accounting or bookkeeping — requires either a whole bunch of fiddle-faddling with numbers or learning how to use double-entry bookkeeping. To produce those statements with an accounting program such as QuickBooks 2012, you have to use double-entry bookkeeping.
You can construct financial statements using the fiddle-faddle method. But the fiddle-faddle method suffers from some really debilitating weaknesses. These weaknesses indicate that you need a better tool. Specifically, you need double-entry bookkeeping.
Most small businesses — or at least those small businesses where the owners aren’t already trained in accounting — have used the fiddle-faddle method. For example, take a peek at the financial statements shown in the following tables. The first table shows the income statement for the one day a year that the imaginary hot dog stand business operates.
| Sales revenue | $13,000 |
| Less: Cost of goods sold | 3,000 |
| Gross margin | $10,000 |
| Operating expenses | |
| Rent | $1,000 |
| Wages | 4,000 |
| Supplies | 1,000 |
| Total operating expenses | 6,000 |
| Operating profit | $4,000 |
This next table shows the balance sheet at the start of the first day of operation.
| Assets | |
| Cash | $1,000 |
| Inventory | 3,000 |
| Total assets | $4,000 |
| Liabilities | |
| Accounts payable | $2,000 |
| Loan payable | 1,000 |
| Owner’s equity | |
| S. Nelson, capital | 1,000 |
| Total liabilities and owner’s equity | $4,000 |
With the fiddle-faddle method of accounting, you individually calculate each number shown in the financial statement. For example, the sales revenue figure equals $13,000. The fiddle-faddle method of accounting requires you to somehow come up with this sales revenue number manually.
You may be able to come up with this number by remembering each of the sales that you made over the day. Or, if you prepare invoices or sales receipts, you may be able to come up with this number by adding all the individual sales. If you have a cash register, you may also be able to come up with this number by looking at the cash register tape.
Other revenue and expense numbers get calculated in the same crude manner. For example, the $1,000 of rent expense gets calculated by either remembering what amount you paid for rent or by looking in your checkbook register and finding the check that you wrote for rent.
The balance sheet values get produced in roughly the same way. You can deduce the cash balance of $1,000, for example, by looking at the checkbook or, in a worst-case scenario, the bank statement. You can deduce the inventory balance of $3,000 by adding the individual inventory item values. You can calculate the liability and owner’s equity amounts in similar fashion.
Some of the values shown in an income statement or on a balance sheet get plugged — meaning that they’re calculated using other numbers from the financial statement. For example, you don’t look up the profit amount in any particular place; instead, you calculate profit by subtracting expenses from revenue. You can also, of course, calculate balance sheet values, such as total assets, owner’s equity, and total liability of owner’s equity.
The fiddle-faddle method of accounting works reasonably well for a very small business as long as you have a good checkbook. So, for a very small business, you may be able to get away with this crude, piecemeal approach to accounting.
But unfortunately, the fiddle-faddle method suffers from three horrible weaknesses for a firm that doesn’t have super-simple finances:
It’s not systematic enough to be automated. You may not care that the fiddle-faddle approach isn’t systematic enough for automation. A systematic approach like double-entry bookkeeping can be automated, as QuickBooks does. This automation means that the task of preparing financial statements requires maybe five mouse clicks.
Because the fiddle-faddle approach can’t be automated, every time you want to produce financial statements, you or some poor co-worker goes to an enormous amount of work to collect the numbers and all the raw data necessary to produce information.
It’s very easy to lose details. You see that the hot dog stand business incurs only three operating expenses: rent, wages, and supplies. If you know the operating expense categories that the business incurs, it’s fairly easy to look through the check register and find the check or checks that pay rent, for example.
You can use a similar approach with the wages and supplies expenses. However, what if you also have an advertising expense category or a business license expense, or some other easy-to-forget category? If you forget a category, you miss expenses.
It doesn’t allow rigorous error checking. Error checking is important with accounting and bookkeeping systems. With all the numbers and transactions floating around, errors easily creep into the system.
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Source:http://www.dummies.com/how-to/content/the-fiddlefaddle-method-of-accounting.html
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